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Friday, October 1, 2010

Public Offers made Public - I

In this series of blogs, I’ll focus on some of the recent changes in the regulations related to public offers. I will also discuss some of the likely impacts of these changes. In the first part I will introduce public offers in brief.

In order to finance their expansion, firms rely on different methods to raise capital. While deciding the mode of financing, the company looks at different aspects of capital i.e. cost of financing, amount of capital required, capital structure, size and reputation of the firm etc. The primary methods used by corporations to raise capital are: Bonds, Stocks, Borrowing & Retained profits. In this blog we will focus on the stocks as a method of financing.

The Stock market acts on two levels - one as a primary market and the other as a secondary market. In primary markets, new stock or bond issues are sold to investors via a mechanism known as underwriting. This process involves the business being 'listed' on the Stock Exchange or 'floating'. In this case, the business will effectively get its capital through the initial sale of its shares.

Having shares available to investors in the open market is known as Public Issue. Public issues can be further classified into Initial Public offerings and further public offerings. In a public offering, the issuer makes an offer for new investors to enter its shareholding family. The issuer company makes detailed disclosures as per the DIP guidelines in its offer document and offers it for subscription. The significant features are illustrated below:

Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer’s securities.

A Further public offering (FPO) is when an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document. An offer for sale in such scenario is allowed only if it is made to satisfy listing or continuous listing obligations.

Disadvantages associated with a company going public:

It involves lot of formalities and expenses, various returns and documents have to be filed with the Registrar of Companies (ROC)/other authorities etc

It involves loss of privacy as many of the returns, resolutions which will be filed with ROC is open to public scrutiny

Members of a company cannot have effective control over its working as in partnership or proprietary business

The law provides for a detailed winding up procedure which is very cumbersome and expensive compared to other organisations like firms

A company has greater public accountability and thus it cannot go against public interest

Few people with business background or with enterprising character can effectively control the entire business with disproportionately low percentage of financial stake, Satyam was controlled by the Raju family with about 3 % stake

Since the control of the company is in the hands of few professionals there is always a chance of defrauding the shareholders and creditors

But even with above mentioned disadvantages, we do come across news regarding companies going public. So, let us now have a look at some of the advantages associated with “going public”.

Going public can help the company raise capital in the stock market which doesn’t attract interest as is the case with debt.

The raised capital need not be repaid.

It allows a company to tap a wide pool of investors to provide it with large volumes of capital.

Going public boosts a company’s reputation which in turn can usually get better rates when they issue debt as they are open for scrutiny.

In case of mergers and acquisitions (M&A), LBOs (leveraged buyouts) are easier to do because stock can be issued as part of the deal.

(This article has been taken from the report titled “Analysis of Recent Trends in Public Offers in the Indian Context (Legal and Financial aspects)” prepared by Rigved Mitra and Saket Saurabh under the guidance of Prof. V.K.Unni)